Problem 1. Which of the following statements is most correct and explain why?
a. Indexing tax brackets reduces the extent of 'bracket creep'
b. Bonds issued by a municipality such as the city of Miami would carry a lower interest rate than bonds with the same risk and maturity issued by a private corporation such as Florida Power & Light.
c. Our federal tax laws tend to encourage corporations to finance with debt rather than with equity securities.
d. Our federal tax laws encourage the managers of corporations with surplus cash to invest it in stocks rather than bonds. However, other factors may offset tax considerations.
e. All of the above are correct.
Problem 2. After tax returns
West Corporation has $50,000 which it plans to invest in marketable securities. The corporation is choosing between the following three equally risky securities: Alachua County tax-free municipal bonds yielding 6%; Exxon bonds yielding 9.5%; GM preferred stock with a dividend yield of 9%. West Corporation tax rate is 35%. What is the after-tax return on the best investment alternative? (Assume the company chooses on the basis of tax-returns)
Problem 3. Forecasting and ratio changes.
ABC Manufacturing has the following historical balance sheet:
Cash $ 20 Account Payable $200
Accounts Rec. 240 Notes Payable $130
Inventory 320 Accruals 30
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Total $ 580 360
Net Plan & Equip. $420 Long Term Bonds $260
Common Stocks 270
Retained Earnings 110
Total Assets $1,000 Total Liabilities & Equity 1000
Over the next year ABC´s current assets, accounts payable, and accruals will grow in proportion to sales. Last year´s sales were $1,500 and this year sales are expected to increase 40% . The firm will retain $68 in earnings to fund current assets growth, and the rest of the increase will be funded entirely with notes payable.The net plant and equipment account will increase to $700 and will be funded directly by a new equity issue.
What will ABC´s current new ratio be after the changes in the firm´s financial picture are complete? What will the quick ratio be and what does the quick ratio reflect in relation to the firms liquidity? Given the information provided in the above balance sheet what is the inventory turnover ratio and what does that ratio provide us in way to evaluating the firms financial management?
Problem 4. Expected Inflation
The real risk-free rate r*, is 3%. Two-year treasury securities yield 7%. Three-year treasury securities yield 7.5%. The treasury securities have a maturity risk premium of 0.1% (t-1), where t=the maturity of the security . Assume that the default risk premium and liquidity risk premium on all treasury securities equal zero. The expected rate of inflation for this year (Year 1) is 4.25%. What does the market anticipate will be the rate of inflation three years from now.
Problem 5. Bond value-semiannual payment
Assume that you wish to purchase a 20-year bond that has a maturity value of $ 1000 and makes semiannual interest of $40. If you require a 10% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?